Contributed by David G. Litvack
Much ink has been spilled over the enforceability of third party releases in chapter 11 plans, including at the BFR Blog here and here.  A recent decision in the United States Bankruptcy Court for the District of Delaware shifts the burden back to impaired creditors to affirmatively opt out of “consensual” releases unless they want to be bound by such releases.  In In re Indianapolis Downs, LLC, Judge Shannon approved third party releases contained in a chapter 11 plan that bound impaired creditors who abstained from voting and otherwise did not affirmatively opt out of the third party releases.  By way of comparison, recent rulings by another bankruptcy judge in the District of Delaware, Judge Walrath, have held that third party releases are not permissible absent affirmative consent.
In Indianapolis Downs, the debtor’s chapter 11 plan contained a provision that released certain third party claims.  Creditors could opt out of the releases by checking a box on the ballot and returning it.  The plan stated that any creditor that failed to opt out, including claimants who abstained from voting on the plan and did not otherwise return a ballot, would be bound by the third party release.  The United States Trustee and other parties in interest argued that binding creditors who abstained from voting to the releases rendered the releases non-consensual and accordingly, impermissible under applicable law.
The Indianapolis Downs court began its analysis by reviewing the current state of the law and noted that courts in the Third Circuit have consistently allowed for chapter 11 plans to provide for third party releases upon consent of the affected party.  In Indianapolis Downs, however, the United States Trustee asserted, among other objections, that the third party releases at issue bound creditors without affirmative consent – something prohibited under applicable precedent.  Judge Shannon, however, held that there is no such “hard and fast rule” that requires affirmative consent; instead, only consent is required.  For example, the Indianapolis Downs court noted that in In re Spansion, Inc., unimpaired classes who were deemed to accept a plan could be bound to third party releases by virtue of their “consent.”  The court also cited to DBSD N. Am., Inc., a decision from the Southern District of New York, which held that impaired creditors who failed to return ballots could be bound to third party releases if those creditors were given adequate notice of the consequences of their failure to vote.  Ultimately, the court in Indianapolis Downs held that impaired creditors who abstained from voting on the plan (and did not otherwise opt out of the releases) were apprised of the consequences of that action and, accordingly consented to the third party releases.
The Indianapolis Downs decision, however, is squarely at odds with other Delaware Bankruptcy Court decisions.  In In re Washington Mutual, Inc., Judge Walrath explicitly held that third party releases can only be effective with respect to those entities that affirmatively consented to such releases by voting in favor of a plan and not otherwise opting out of the releases.  In fact, Judge Walrath, citing to In re Zenith Elecs. Corp., held that “[f]ailing to return a ballot is not a sufficient manifestation of consent to a third party release.”
Although Indianapolis Downs may now signal good news for debtors in Delaware, the precedential value of the decision will only be determined in time.  Stay tuned for further updates on this rapidly evolving topic.
Disclosure: Weil represented the debtors in the Washington Mutual, Inc. bankruptcy case.